Who is Warren Buffett?, The Graham-Buffett Investing Strategy

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J. Royden Ward writes: Warren Buffett is my hero. In my mind, he is the best investor ever. If you had invested in one share of his Berkshire Hathaway (BRK-A) 25 years ago when it sold for a mere $3,030 per share, your one share would now be worth $143,000 today. The increase works out to a compound annual growth rate of 16.7%. You would have doubled your investment every four and a half years!

Warren Buffett Stocks

How did Mr. Buffett achieve such remarkable returns? He invested in undervalued high-quality companies using a fundamental value approach. His largest holdings include: Coca-Cola, Wells Fargo, IBM, American Express, Proctor & Gamble, Wal-Mart and Johnson & Johnson. Warren Buffett has owned these leading companies for decades while ignoring the many ups and downs of the stock market.

Warren Buffett is someone I admire not only for his legendary investment skills, but also for his intelligence, wit, down-to-earth personality and generosity. Known as the “Oracle of Omaha,” his investing prowess has propelled him to become one of the wealthiest people on the planet.

Warren believes the U.S. economy will strengthen during the next several years, because the American free enterprise system is alive and well and has worked splendidly during our 200-year history with the exception of a few minor glitches. And there is no reason to believe that America will fall apart during the next century or two.

Warren Buffett Biography

Buffett graduated from the University of Nebraska at Lincoln with a B.S. degree in Business Administration. He then enrolled at Columbia Business School after learning that Benjamin Graham, author of one of his favorite books, The Intelligent Investor, taught there. He earned an M.S. in Economics from Columbia Business School in 1951 at the age of 20.

In 1954, Buffett convinced Benjamin Graham to hire him as a securities analyst in New York. When Mr. Graham retired two years later, Buffett started his own investment company. His initial investments in Berkshire Hathaway, a textile manufacturing company based in New Bedford, Massachusetts, and Government Employees Insurance Co. (GEICO), originally located in Washington D.C., became huge investment successes. They provided the foundation to generate large investment profits and cash flows. The profits and cash flows could then be invested in additional stocks. This simple formula snowballed into millions and then billions of capital under management.

The profit formula was simple, but Buffett’s investment strategy was more complex. He never strayed from what he learned from his mentor from many years ago, Benjamin Graham. Wait patiently for the stock price to decline to the desired level. Buy when the stock price is well below the value of the company. Hold forever.

Warren Buffett stated clearly: “The basic ideas of investing are to look at stocks as business, use the market’s fluctuations to your advantage, and seek a margin of safety. That’s what Ben Graham taught us. A hundred years from now they will still be the cornerstones of investing.”

Value versus Growth

I want to comment briefly on another, related subject: Value versus Growth. I have always advised my readers to divide the stock portion of their portfolio into 50% value stocks and 50% growth stocks. Many investors, though, load up on growth stocks. They are exciting and fun, but value stocks will perform as well as growth stocks, will give you a smoother ride, and provide you with higher dividends. Just ask Warren Buffett.

The Intelligent Investor

Want to invest like super-investors Graham and Buffett? I strongly recommend reading Benjamin Graham’s book, The Intelligent Investor. In the book, Graham provides easy-to-use checklists to find stocks that are selling for less than they should be: stocks that will beat the market with minimal down-side risk. The Intelligent Investor is easy to read and easy to implement. Warren Buffett described the book as "by far the best book on investing ever written."

The Graham-Buffett Strategy

Here are eight guidelines to get you started in the right direction. You can read other guidelines and find out what Warren Buffett’s current holdings include at: www.buffettbuys.com.

For this Cabot Wealth Advisory, I combined Warren Buffett’s and Benjamin Graham’s criteria for choosing stocks. To find investment opportunities for you, I looked for stocks with:

1) Free cash flow more than $20 million – cash needs include dividends, operating expenses, capital improvements, and research.
2) Net profit margin more than 15% – a good indicator of growth sustainability.
3) Return on equity more than 15% – a barometer of future appreciation.
4) Discounted cash flow value higher than current price – Standard & Poor’s is a good source to find discounted cash flow estimates.
5) Market capitalization more than $1 billion – small companies not allowed.
6) Standard & Poor’s rating of B+ or better – indicates financial stability and steady growth of earnings and dividends.
7) Positive earnings growth during the past five years with no deficits – very important.
8) Dividends currently paid – always important and helps your return, too.

I screened my Benjamin Graham Common Stock Database and found two high-quality companies that fit the above criteria. Both companies are leaders in their sector, and both have excellent future prospects.

Aflac (AFL: 52.93) is the world’s largest supplemental cancer insurance provider, deriving 75% of its business from Japan. Most of Aflac’s policies are individually underwritten and marketed at worksites through independent agents, with premiums paid by the employee.

Aflac Japan’s insurance products are designed to help pay for costs that are not reimbursed under Japan’s national health insurance system, and include supplemental health and life insurance. Aflac Japan provides insurance to one out of every four Japanese households.

Aflac has expanded its product line and added new marketing venues in recent years. Non-cancer insurance policies now account for 70% of new sales. Aflac’s rapid growth in Japan is propelled by its success in selling through banks and post offices where sales reps are located.

Aflac’s focus on new products, such as hybrid whole life insurance products, and its successful promotions in Japan are performing well. Sales increased 15% and earnings per share (EPS) rose 40% during the 12 months ended 12/31/12. Insurance policy sales in Japan are growing more rapidly than expected.

Growth should continue at a rapid pace in 2013, too. Japan’s new prime minister has announced several worthwhile programs to bring Japan’s economy out of the doldrums, which will help Aflac’s sales. In addition, sales in the U.S. sales have improved noticeably.

AFL shares sell at 9.1 times 2012 EPS of 5.85, which is well below Aflac’s 10-year average P/E of 10.6. Lower risk in Aflac’s bond holdings and further successes in Japan will produce strong growth in future years. AFL shares are Low Risk and sell at a deep discount to Standard & Poor’s discounted cash flow value of 79.80. The 2.6% dividend yield adds significant value. I expect AFL to increase to my Minimum Sell Price target of 79.75 within one to two years.

BB&T Corp. (BBT: 30.26), founded in 1872 and based in Winston-Salem, North Carolina, BBT provides checking and savings, loans and other financial products and services in the Southeastern U.S. with a high concentration of customers in Virginia, North Carolina and Florida. BB&T has 1,800 branches and $178 billion in assets.

BB&T has taken advantage of attractive buying opportunities during the past four years. The company has acquired Haven Trust Bank, BankAtlantic and parts of Colonial Bank. Earlier, in 1995 and 1997, BB&T merged with Southern National Corp. and purchased United Carolina Bancshares.

Management expects to easily comply with new U.S. government rules and regulations, including Dodd-Frank and the Volcker Rule. Consumer protection regulations will increase some expenses, but not significantly.

Loans increased 8% and EPS soared 45% in 2012. BB&T is taking market share from other banks and is improving the quality of its investment holdings. Underperforming assets fell to the bank’s lowest level since 2008, and BB&T has stopped holding low-yielding mortgages.

I forecast loan growth of 5% and earnings per share growth of 10% in 2013. The acquisition of BankAtlantic, based in Florida, could send revenues and earnings higher than expected. With a current P/E (price to earnings) ratio of 11.4 and a dividend yield of 2.8%, BBT shares are undervalued. BBT is medium risk. BBT shares sell at a deep discount to Standard & Poor’s discounted cash flow value of 39.30. I expect BBT to increase to my Minimum Sell Price target of 38.75 within one year.

I will continue to follow Aflac, BB&T and other blue-chip, high-quality companies in my Cabot Benjamin Graham Value Letter. My March issue will include an eight-page feature on undervalued Graham-Buffett type stocks. I hope you won’t miss it!

Sincerely,

J. Royden Ward

© 2013 Copyright J. Royden Ward - All Rights Reserved

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